External audit is a statutory requirement for an independent examination of the financial statements by an external auditor appointed by the board or business owners. Companies’ internal teams may prepare the financial statements, but only a certified external auditor can vet their compliance with the provisions of IFRS and other applicable laws. An audit is a process of analyzing the company, their finances or operation, carried out by an independent auditor. The basic purpose of the audit is to provide independent assurance that management has, in its financial statements, presented a “true and fair” view of a company’s financial statements.
As stated above, auditing is a process used by an executive to identify potential problems in the finances or conduct of his business in order to improve efficiency & minimize potential risk to the business. It is, therefore, a question of verifying that there is no fraud or omission that could change the economic reality of the business. A rigorous audit process will also, almost invariably, identify areas where management may improve their controls or processes, further adding value to the company by enhancing the quality of its business processes.
Importance of Auditing in Business
A company must ensure that its resources are used efficiently to ensure its financial well being & stability. It is also about meeting commitments made to clients, suppliers, creditors and, if any, employees. Companies are believed to comply with the legal rules, in particular in the field of labor law and payment of different taxes. The mission of the auditor is to provide a professional diagnosis of the financial status of the company. This report will then serve as a confidence notice for future creditors or investors of the company. Those who take vital decisions based on the financial condition of a business need the most reliable & assured financial information. Whenever various stakeholders viz bankers, suppliers, investors, and potential merger partners need to appraise a company, they choose to have statements that have passed a rigorous examination by auditors.
Auditing is, undoubtedly, a mode of evaluating the effectiveness of a company’s internal controls. Maintaining an efficient system of internal controls is vital to achieve a company’s business objectives, obtaining reliable financial reporting on its operations, preventing fraud and misappropriation of its assets, and minimizing its cost of capital. Both in house and external auditors contribute to a company’s audit system in different but important ways.
Enables the Pursuit of Business Objectives
Having an effective audit structure is important for a company because it enables it to pursue and attain its various corporate objectives. Business processes need various forms of internal control to assist regulation and monitoring, prevent and detect irregular transactions, measure ongoing performance, maintain adequate business records and to promote operational productivity. Internal auditors review the blueprint of the internal controls and informally put forward improvements, and document any substantial irregularities to enable further investigation by management if it is acceptable under the circumstances.
Assess the Risk of Misstatement
Auditors assess the risk of material misstatement in a company’s financial statements. Without a system of internal controls or an audit system, a company would not be able to create reliable financial reports on which stakeholders could rely. Thus, it would not be able to conclude how to allocate its assets and would be unable to know which of its segments or product lines are profitable and which are not.
Additionally, it could not manage its dealings, as it would not have the ability to tell the status of its assets and liabilities and would be rendered varying in the marketplace due to its inability to constantly produce its goods and services in a reliable fashion. Accordingly, an audit system is crucial in preventing incapacitating misstatements in a company’s records and reports.
Fraud Prevention and Detection
Internal audit serves an important role for companies in the prevention of frauds. Persistent analysis of a company’s operations and maintaining rigorous systems of internal controls can prevent and detect various forms of fraud and other accounting irregularities. Audit professionals assist in the design and modification of internal control systems the purpose of which includes, among other things, fraud prevention. An important part of prevention can be avoidance, and if a company is known to have an active and diligent audit system in place, by reputation alone it may prevent an employee or vendor from attempting a scheme to defraud the company.
Cost of Capital
The cost of capital is of utmost importance for every company, regardless of its size. It is largely comprised of the risk associated with an investment, and if an investment has more risk, an investor will require a higher rate of return to invest. Well-built audit systems can reduce various forms of risk in an enterprise, including the risk of material misstatement in financial reporting, the risk of fraud and misappropriation of assets, as well the risk of suboptimal management due to insufficient information on its operations.
Process Improvement and Efficiency
Internal audit is a great tool to help companies understand two key aspects:
a. whether the current operations follow the agreed process, and
b. how efficient the current processes are
This often leads to embracing new technologies and creating new processes that make the overall operations more efficient. Savings on costs and time by reducing wastage, removing the non-value-add process parts, etc. can help organizations build profitability. At times, a system of regular internal audits can prove to be an eye-opener for organizations, as it can challenge processes that have prevailed over the years. Internal audit can bring ongoing and continual process improvements, and help organizations stay ahead of the competition.
Last Updated: 8th April 2019
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Tag: Audit, Business, Importance